Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if ITT (NYSE: ITT ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let's take a closer look at ITT.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||9.6%||Fail|
|1-Year Revenue Growth > 12%||4.0%||Fail|
|Margins||Gross Margin > 35%||29.0%||Fail|
|Net Margin > 15%||6.9%||Fail|
|Balance Sheet||Debt to Equity < 50%||30.2%||Pass|
|Current Ratio > 1.3||1.70||Pass|
|Opportunities||Return on Equity > 15%||14.6%||Fail|
|Valuation||Normalized P/E < 20||13.4||Pass|
|Dividends||Current Yield > 2%||1.7%||Fail|
|5-Year Dividend Growth > 10%||21.4%||Pass|
|Total Score||4 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
ITT's total score has forced shareholders to play defense lately. The contractor is facing the same woes that plague the entire defense industry, but it also has some disadvantages compared to its competitors.
Lately, investors have left many defense stocks for dead. With concerns about the future prospects for federal government defense spending, shareholders have cut valuations on the entire sector to levels well below the overall market. And even though some believe that those concerns are largely unwarranted, you can still find extremely reasonable prices for defense stocks.
The problem for ITT, though, is that it doesn't match up well against some of its peers. At less than 2%, ITT lacks the higher dividend yields that Lockheed Martin (NYSE: LMT ) , Northrop Grumman (NYSE: NOC ) , and Raytheon (NYSE: RTN ) offer. Yet at the same time, all three of those stocks, as well as L-3 Communications (NYSE: LLL ) and General Dynamics (NYSE: GD ) , trade at lower multiples than ITT.
In addition, although backlogs have generally been on the rise in the industry, ITT saw a substantial decrease over the past year, with backlog falling more than 14%. With L-3 and Lockheed posting backlog gains, ITT seems to be moving in the wrong direction.
Defense stocks are an interesting value play right now. But ITT doesn't appear to be the best value in the sector. Even if budget fears prove overblown, ITT may not benefit as much as its rivals, leaving it well short of perfection.
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.
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Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."